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China's private airlines sent into a tail-spin

Theatre may not be its core business, but the airline industry has certainly been producing one drama after another in recent months. Two fleets grounded, debts piling up, passenger numbers down, a State-funded takeover the list goes on. So, what has happened to China's private airlines?

It is not a question easily answered, with some blaming an "unfair market", others the global slowdown. But no matter the cause, many now fear the crisis hitting the sector can only be solved with a massive overhaul of the industry - or it may soon start hitting passengers in the pocket.

The latest drama to take center stage has been the grounding of East Star Airlines, a small private carrier based in Wuhan, the capital of Hubei province. With a fleet of 10 aircraft running almost 30 flights a day, it was ordered to cease services by the Civil Aviation Administration of China (CAAC) on March 15, the same day its president, Lan Shili, was seized by police at Zhuhai Airport as he boarded an international flight, reported Caijing.com.

Tan Shizhang, a spokesman for Wuhan's communications committee, said it had demanded the cessation order because the firm was debt-ridden, thereby jeopardizing transport safety. However, an East Star source told Guangzhou Daily it was more to do with Lan's refusal to allow his firm - which accounts for 10 percent of the local market share - to be acquired by China National Aviation, the parent company of Air China.

The two had been in negotiations for some time before 43-year-old Lan, who is believed to have Singaporean citizenship, suddenly released a statement on the company's website on March 13 rejecting the deal. China National Aviation had already injected 50 million yuan (7.3 million U.S. dollars) to prop up the struggling firm.

East Star now faces bankruptcy, with the Intermediate People's Court in Wuhan recently announcing it had accepted a lawsuit filed by six creditors, including General Electric's aircraft leasing arm GE Commercial Aviation Services, and frozen the airline's 16 accounts.

The incident came three months after the Tianjin-based Okay Airways was grounded for around 30 days, this time over an internal dispute between its controlling shareholder and management team, and just three days before the debt-ridden United Eagle Airlines, based in Sichuan province, received 200 million yuan from Sichuan Airlines, making them the first private airline to be taken over by a State-owned rival.

And for similar carriers, the outlook is far from rosy, analysts have said, despite CAAC director Li Jiaxiang saying this week Chinese airlines made an estimated 800-million-yuan profit in the first quarter thanks to a rebound in domestic travel and the government's supporting measures.

Figures for Spring Airlines show the Shanghai company made more than 20 million yuan last year, 70 percent less than in 2007, while the Nanfang Weekly in Guangzhou reported the profit was partly because of a payment from a CAAC fund set up to support civil aviation infrastructure construction.

Overall, the entire air transport industry in China suffered a record 25.2-billion-yuan loss during 2008, said Li on Wednesday.

Most have put the slump in the air travel sector down to the global economic recession. Passenger volume fell sharply across the world in February to 10.1 percent compared to last year's results and 5.6 percent compared to January, according to the International Air Transport Association (IATA).

"The gloom continues. The sharp drop in February passenger traffic shows the broadening scope of the crisis," said Giovanni Bisignani, the director-general and CEO of the IATA.

After a fall in demand for long-haul flights last year, major State-owned carriers shifted their focus to the domestic market, which further intensified the competition. But although the CAAC reported an air traffic hike in January, analysts at IATA suggested the figures may have been distorted by the Chinese New Year.

"Airlines are still operating under great financial pressure now, following months of continuous losses," said Li Lei, an aviation expert with CITIC China Securities. "And with a limited amount of capital in hand, private carriers are especially vulnerable."

To set up a private airline, a firm must first have 80 million yuan in registered capital, while most are run by parent companies that also have interests in tourism, real estate and hotels. But as explained by Yang Zhiqing, an analyst with Changjiang Securities, "this business model is likely to cause problems for the parent company's resources allocation and fund utilization. The company's financial situation is likely to deteriorate, resulting in a break in its funding chain."

Guangzhou Daily reported Lan Shili's East Star Group was not only involved in air transport, but also in catering, tourism and real estate. He claimed the group had assets worth 3 billion yuan and had an annual income of 500 million yuan. But the newspaper revealed the group does not even own a building, instead it rents office space.

The airline has not paid its employees since December, nor its airport bills, including a 50-million-yuan landing fee to Wuhan Tianhe, added the city's communication committee spokesman Tan. He revealed East Star had only 3.2 million yuan in its accounts.

As well as the financial crisis, private airlines are also forced to operate in an unfair environment, claimed a senior manager at one firm, who insisted on anonymity. He said private companies were treated entirely differently from their State-owned counterparts.

"Many airports only supply aviation oil when we pay on the spot with cash, but State-owned carriers do not need to. Also, State-owned carriers get cash injections from the government, while private airlines do not enjoy such support," he said.

Since December, it has been announced China Eastern and China Southern will receive a total of 10 billion yuan from the government to help them ride out the slump, with many expecting China National Aviation to get at least 3 billion yuan. Meanwhile, parent companies of Shanghai Air and Hainan Airlines have won support funds from local governments.

But many industry observers do not agree with the bailouts, arguing that private airlines are "congenitally deficient".

Li Xiaojin, a professor at the Civil Aviation University of China in Tianjin, said most investors entered the private airline market with an impulse to make easy money. He explained: "China's air transport industry reaped an unprecedented harvest in 2004. The profit they earned that year was said to equal what they have earned in the decade before.

"Thinking the spring of China's air transport industry had arrived, private airline investors dived into the market hoping to earn a fortune. Most of them knew little about the industry's nature and were unprepared for the future risks."

Xu Lingjie, a scholar with the Civil Aviation Flight University of China, said that to many people's surprise the airline industry was actually all about capital and technology.

"It is an industry demanding high input but producing low output An airline will not only need a fleet but must also pay for expensive aviation equipment, fuel and airport services," she said. "If you are an investor only with money, you should not risk entering this market in haste. It is better you first evaluate your capabilities before stepping into this industry."

Li at the Civil Aviation University of China feels the global financial crisis will eventually lead to the restructuring of China's air transport industry, but dismissed claims only large State-owned companies would survive the slump.

"China's market will become more mature. There will be various carriers, not only State-owned but also private-owned, large international carriers and mini, low-fare ones," he said.

His comments will do little to quell the fear that China's private airlines, which have helped substantially cut the cost of tickets, will eventually be swallowed up by their State-owned counterparts, sending prices soaring again. However, Zou Jianjun, an associate professor at the Civil Aviation Management Institute of China, said the number of airlines had little impact on the costs for customers anyway.

"Long before the entrance of these private carriers there were four national airlines and four regional airlines competing in the market," he said. "The fall in prices in recent years is not because of private airlines, it is the result of the expansion of airlines and their capacities."

Despite an uncertain future, Wang Jinjun, chairman of Okay Airways, remained confident of his company's chances of survival.

"The market needs multiple products, and private carriers can be complementary to State-owned airlines," he added. "Private carriers will not account for a large market share but, as long as they are positioned right, they can still accomplish something big."